Earnest Money: Why You Need It

What is Earnest Money?

Earnest money is an important part of the home buying process. It helps prove to the seller that you are a committed (earnest) buyer, and it helps fund your down payment at closing. This check, along with your check for the option period, are submitted with your offer to begin the process of buying a home. The earnest money check is made payable to the title company that will be closing the transaction, while the option money check is made out directly to the seller. Earnest money is also known by some other names in other locations: good faith deposit is one of the most common. If a buyer were to default on the contract, this money could possibly be retained by the seller as part of the “buyer’s non-performance” clause according to the terms of the contract.

How much earnest money is common?

Common practice in the Austin area is for earnest money to be roughly 1% of the sales price of the property. For example, on the purchase of a $300,000 house, a common amount of earnest money would be $3,000. However, there really are no rules and a seller could request additional earnest money or a buyer could offer less and the contract would be perfectly acceptable. Each offer and negotiation is different, so there are many factors that could play in to determining an amount.

How is the Earnest Money Handled?

Once a contract is executed by all parties, the title company will sign a receipt that acknowledges the contract and the earnest money. They will then deposit the earnest money check into an escrow account until it is utilized at closing. Please note: the check WILL be cashed. If everything goes as planned, the earnest money will show up as a credit to the buyer at closing and generally will simply reduce the amount of cash a buyer needs to bring to closing.

If the contract does not make it to closing, the earnest money is at risk. If a buyer terminates the contract during the option period or for reasons clearly permitted by the terms of the contract, the buyer should be able to receive the earnest money back. A written authorization signed by both buyer and seller has to be sent to the title company requesting the release of funds to the buyer. Title companies cannot legally release funds without the permission of all parties.

If the buyer defaults on the contract however, the funds should be released to the seller. Determination of what constitutes a true default should be made under the advice of legal counsel and other remedies may be available to a seller above and beyond just those funds. However, even in the case of a buyer default, written authorization by all parties to the title company to release funds is still required.

If the seller defaults (again, you should consult with an attorney to determine default and remedies), the buyer may be entitled to a release of the earnest money funds back to them. Once again, written authorization of all parties is needed by the title company.

Can Earnest Money Affect Negotiations?

Not surprisingly, earnest money can be used as a negotiation tool to help strengthen an offer. Yes, it can. If you have two otherwise seemingly equal offers, but the second one has a higher earnest money amount, a seller could be more likely to pick this second offer. Reasons could include that the buyer is showing a willingness to invest more in the deal from the beginning. It also shows that the buyer may have access to more funds and may therefore be a stronger loan candidate. This is not always the case, but these factors could play a role in a negotiation especially during multiple offer situations.